The following OECD assessment and recommendations summarise chapter 2 of the Economic Survey of Hungary published on 11 February 2010.

Contents

How to ensure fiscal sustainability?

A major step toward fiscal sustainability has been taken with the adoption of the fiscal responsibility law that introduced strict fiscal rules and established a non-partisan fiscal council to oversee implementation. The new fiscal council holds the potential to raise public awareness about the need for fiscal consolidation and to ensure “checks and balances” for fiscal policy implementation. Hence, it is of utmost importance that the fiscal council benefits from broad political acceptance. The new fiscal rules aim at lowering the debt-to-GDP ratio over time and introduce annual spending targets for each of the next three years. By focusing on the debt ratio and moving towards a medium-term expenditure setting, the framework deals appropriately with Hungary’s sustainability challenge given politicians’ proclivity to overspending during election years. The Fiscal Responsibility Law has just begun to be implemented and, with two major elections taking place in 2010, it would be best to allow some experience to accumulate before considering substantial changes. However, the operational framework of the rules appears to be somewhat complex. To increase public ownership of the rules, the fiscal council should prepare, as soon as possible, an operational manual describing the step-by-step process for implementing the rules, including key budgetary variables, dates and responsible governmental and parliamentary units.

As mentioned above, the recent changes in the tax system, by switching from labour to consumption taxes, are steps in the right direction. However, at a constant level of taxation, economic distortions could be reduced by considering further cuts in labour taxes, financed through higher property taxes (accompanied by improved property registry) and/or emissions taxation. Further tax cuts would also increase welfare gains since marginal tax rates are high, with negative impacts on growth and employment. However, this would require first to reduce the size of the government – which is very high in Hungary, especially in comparison to countries with similar living standards – so as not to deteriorate fiscal sustainability. A striking feature in Hungary is the large share of public service expenditure, suggesting inefficient public administration. Another feature is the comparatively high level of outlays on social protection, reflecting generous social transfers and attractive incentives for early retirement, despite recent measures taken by the government. Finally, health-care spending, while not dramatically different from most OECD members, does not deliver adequate outcomes by international standards. While some improvement has been made, further efforts are needed to increase efficiency.

Hungary’s public administration is one of the least efficient among OECD and accession countries, pointing to potentially large efficiency gains (Figure 2). One potential source of savings appears to lie in reduced staffing; central and sub-national workers account for almost 20% of total domestic employment, which is high in comparison with other OECD countries, although it reflects low total activity ratio as well. Hence, the government should continue to streamline public sector employment. Another source of saving could be outsourcing, given that the degree of outsourcing is rather low in Hungary at the central government level compared to other countries. Greater use of outsourcing for public services could raise efficiency of service provision, but care would have to be taken to ensure transparent and competitive contracting, to reduce the risk of corruption. This would require the government to strengthen public procurement monitoring capacity and the State Audit Office, and enhance the political will in support of the Office’s enforcement. The recent legislation enhancing the control mechanism of the Public Procurement Office is a step in the right direction. More generally, to help maintain the momentum of public administration reform, the government should establish a unit with a mandate to both promote and assess reform progress. It should also revisit and pursue recommendations of the 2006 State Reform Council’s comprehensive stocktaking of overlapping tasks in government agencies.

Estimated public service efficiency frontier in OECD countries

1. A composite indicator for public administration outcome based on international surveys on the quality of justice and the level of corruption, both taken from the Global Competitiveness Report, and the levels of bureaucracy in the economy measured by OECD’s Product Market Regulation indicator.
2. Spending in 2006 for Canada and Slovenia, 2005 for New Zealand. Spending on general public services (excluding interest payments) and public order and safety.Source: OECD calculations based on OECD (2009), OECD National Accounts Statistics (database), October; WEO (2008), The Global Competitiveness Report 2008 2009, World Economic Forum; OECD (2009), International Regulation (database), July.

A major challenge for public expenditure reduction is the anticipated rise in public expenditure related to ageing. Past and recent reforms of the pension system – in 1998, 2007 and May 2009 – should lead to a slower increase in pension costs. In the future, the government should increase the statutory retirement age in line with increases in life expectancy.

The health status of the Hungarian population is among the poorest in the OECD; in particular, male life expectancy at birth is the lowest, while that of women is the second lowest. Despite multi-casual factors, one of the most important determinants is the health-care delivery system. Although Hungary’s public expenditure on health care is below OECD and EU15 averages, the share of private spending on health (including the traditional under-the-table payments) is estimated to be the highest in the EU, at around 30% of total spending on health. There is thus an obvious need to raise “value for money” in the health sector, all the more so in light of impending ageing-related growth in demand for health services.

Recently, the government has achieved some successful reforms, principally in reforming the pharmaceutical market, but the reform agenda spelled out in previous OECD Surveys remains mostly valid. Efforts to tackle the thorny issues of formal patient co-payments and devolution of the payer function from the Social Security Fund to a mix of private/public insurance schemes have encountered strong political resistance. The authorities should seek consensus toward the goal of introducing patient co-payment to instil some cost-consciousness and help eliminate under-the-table payments. The authorities should also continue to strengthen the gate-keeping role of general practitioners. Reform is also crucial for the government to be in a position to manage the financial impact of ageing-related increases in health-care spending. Based solely on ageing, Hungary’s public spending on health care is projected to increase relatively modestly, but the government should plan for possible long-term budgetary impacts of rising demand, and especially the likely greater use of more costly improved medical technologies.

How to obtain this publication

The complete edition of the Economic Survey of Hungary is available from: